RISK ASSESSMENT

Growth continues to accelerate

After stagnating in 2017 due to the decline in private and public investment following a political crisis, growth rebounded in 2018 and will remain on an upward trajectory in 2019. Demand, both domestic and external, will stimulate economic activity. The slight pick-up in inflation on higher food prices will not adversely affect household consumption, which will continue to increase, driven by job creation, an increase in the minimum wage and improved social protection. Demand from European countries –Macedonia’s main trading partners, especially Germany (40% of total exports) – will remain robust and will support exports of automotive parts, chemicals, and construction materials. In addition, private investment is set to increase, particularly in the energy sector, helped by a more stable political situation and the new energy law, which includes measures to liberalise the electricity market from 2019. Similarly, public investment will gain momentum thanks to new EBRD support, €7 million of which will be allocated to building a photovoltaic power plant, while €10 million will go towards improving and increasing the provision of public services, in particular transport. Business activity will also be supported by easier access to credit as an accommodative monetary policy is maintained.

Fiscal discipline hampered by the informal economy

The government deficit is expected to decline slightly thanks to the continued austerity policy. The government aims to consolidate the pension system and promote social equity. This will result in an increase in the social contribution rate, a higher tax rate for capital income, as well as improved targeting of social assistance programmes by replacing the parental allowance for a family’s third child by a means-tested guaranteed minimum income. However, the effectiveness of fiscal policy remains constrained by tax evasion and the large informal economy, which makes it difficult for the government to reduce the deficit. The successive accumulation of deficits, coupled with breaks granted to foreign investors (ten-year tax exemption and free access to public services), is responsible for the rise in debt. Although largely contracted with non-residents (70% of the total in 2017) and denominated in euros, the debt is not exposed to exchange risk, as the national currency is pegged to the euro.

Turning to the external accounts, the current account deficit is expected to widen due to a deterioration in the trade balance. Exports will grow less rapidly than imports of refined oil and capital goods, which are increasing with construction projects. However, the services surplus (3.5% of GDP in 2017) and remittances from expatriate workers (16% of GDP) largely offset the trade deficit. The current account deficit is financed by foreign investment (equivalent to 2.5% of GDP in 2017). Gross external debt (80% of GDP in June 2018) should be put into perspective: with two thirds of it coming from private commitments linked to foreign investments, the debt only represents 28.4% of GDP in net terms. The country’s substantial foreign exchange reserves (four months of imports in 2017) cover the short-term portion, which makes up a quarter of the total.

EU and NATO membership are the primary objectives

The Social Democratic Alliance of Macedonia (SDSM), led by Prime Minister Zoran Zaev, took power in May 2017, ending two years of political crisis. The SDSM has formed a coalition including parties representing the Albanian minority, the DUI, and the AA, and, recently, the DPA, enabling it to strengthen its parliamentary majority, with 67 seats out of 120. The opposition, represented by the former ruling party VMRO-DPMNE, has lost popularity after former Prime Minister Nikola Gruevski was accused of abuse of power, electoral fraud, and criminal ties (he has since left the country and gone to Hungary). The government's main objective is still membership of the European Union and NATO, which is why it is building peaceful relations with Greece. Greece had initially blocked the dual membership process, refusing to have a neighbour called Macedonia, which is already the name of a Greek region. The Parliament therefore voted in September 2018 to adopt a new name – the Republic of North Macedonia – which was approved by Greece. Accession negotiations can thus be resumed at the European summit meeting in July 2019, but will remain dependent on the government’s ability to pursue reforms to address Macedonia’s structural problems. While within the (duty-free) Industrial and Technological Development Zones, foreign companies benefit from significant tax breaks and low labour costs, they also have to cope with a shortage of skilled labour, inadequate infrastructure, insufficient resources allocated to research and development, slow domestic payments, lengthy court procedures and corruption.